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Of all the health care reform proposals bouncing around the halls of Congress, none is as divisive as the "public option," a government-run insurance plan that would compete against private insurers. Proponents claim it will drive down prices. Critics worry it could destroy private health insurance and result in a government takeover of health care.

But very few observers have acknowledged another effect of the public option, one that would spell disaster for reeling state budgets: the public option will cause state tax revenues to plummet.

How so? Taxes paid by private insurers are a major source of income for most state governments. For instance, in at least 37 states, HMOs pay premium, income, corporate, or franchise taxes, with rates as high as 3.5 percent.

Similarly, Blue Cross Blue Shield plans, many of which are not-for-profit, pay premium taxes in at least 34 states.

A new public insurance program run by the feds will poach customers from private insurers, driving many out of business in the process. And if there are fewer private insurance companies -- and fewer privately insured consumers -- it follows that state insurance tax revenues will dwindle.

How will the public option possibly wreak such havoc on private insurers and state budgets alike? For starters, it will be able to attract patients with below-market prices. The plan won't have to worry about making money, as any losses can be erased by dipping into the federal treasury.

The public option will also be able to reimburse doctors and hospitals at artificially low rates. The federal government's existing public options, Medicare and Medicaid, are notorious for routinely underpaying health care providers by 20 percent.

Providers make up for such short-changing by charging privately insured patients more. Milliman Inc., a consultancy, estimated that Medicare and Medicaid offloaded $88 billion to private patients in 2007. As a result of such systematic underpayment, the average family of four shells out an extra $1,500 a year in insurance premiums.

If the public option employs reimbursement rates similar to Medicare's -- which it, no doubt, eventually will -- private patients will face even higher premiums, thanks to even more Medicare-style cost-shifting. As private insurance becomes less affordable, more and more patients will flee to the lower-priced public plan.

The Lewin Group found that the public option could cause nearly six of every 10 Americans with private coverage -- roughly 118 million people -- to switch to public insurance.

Now, federal insurance programs don't pay state taxes. If patients leave private insurance companies in droves, those firms' revenues will decrease significantly. And that will yield an equally severe dip in tax revenues for the states.

For most states, such a drop in tax income would be catastrophic. The recession has already left many deeply in the red. The Rockefeller Institute of Government calculates that state tax collections fell by nearly 12 percent over the first four months of the year -- a record high.

Fully 45 states are facing budget shortfalls this year. New York's is a whopping $18 billion. New Jersey's is nearly $9 billion and Florida's is $6 billion.

The fiscal situation isn't going to get better for state governments anytime soon. Nearly two-thirds have projected budget gaps for 2011, and at least 15 expect gaps in 2012.

Over 90 percent of taxes paid by insurers fund programs unrelated to insurance. In North Carolina, for instance, taxes on insurance premiums finance firefighting equipment. Without tax revenue from insurers, state governments will likely be forced to cut funding for vital programs.

A public option could make the states' terrible fiscal situation even worse. By driving private insurers from the market, the public option would scrap a vital source of state tax revenues and push state governments to the brink of insolvency.

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About the Author

Janet Trautwein is the chief executive officer of the National Association of Health Underwriters. She is the association’s primary representation to the media, government agencies and elected officials at all levels. Prior to becoming the CEO of NAHU in 2005, Janet served as the head of NAHU's ... More